Futures Spreads Simplified

If futures spreads are not part of your trading plan, you may be missing the boat.

In fact, for the smaller retail account crowd, spread trading can have some significant potential benefits.

Before we move on, know that spreads are no less risky than trading outright contracts.

Spreads may potentially offer a way of trading with lower margin requirements, better trend potential and better potential ROI. In addition, spread trading focuses on the relationship between two contracts rather than market direction.

Here’s an example to help you out:

If in December 2015, corn futures are priced at a significant discount to December 2016 corn futures, a trade opportunity may potentially exist.

Let’s assume that the spread between these two contracts has widened out to $.25 per bushel. In other words, December 2016 corn is priced $.25 per bushel higher than the 2015 contract. Let’s further assume that you believe that near-term demand for corn may increase given recent poor weather conditions. You can conclude that the 2015 corn contract is likely to rise, while the 2016 corn contract is likely to fall, or a combination thereof.

In this case, you could simply buy the 2015 corn contract and sell the 2016 contract at a spread of $.25 per bushel simultaneously.

If the spread begins to narrow, you will potentially make money on the trade. If the spread continues to widen, you are wrong on the trade and will be losing money.

Whether corn goes up or down, you are simply concerned with the relationship, or spread between the two contracts.

Spreads have a tendency to trend, and can potentially provide solid trading opportunities that may not move as quickly as an outright long or short position in the underlying.

Let me know if you have any questions about this or you want to learn more about future spreads in other upcoming posts.